Ask Colin

Why do your moving averages never seem to touch the price bars?

I assume you know what a moving average is. If not there are articles on my members web site

www.bwts.com.au (not free) and on the internet (free). Just put "Moving average into Google" and you should find lots of explanations like http://en.wikipedia.org/wiki/Moving_average

A moving average is simply a technique to smooth out fluctuating data to disclose a trend. There is only one parameter - the number of periods over which it is calculated.

The larger the number of periods, the smoother and the slower the moving average.

So, if you take one extreme - a ONE period moving average, you are actually drawing a line through the daily closing prices. Even in a very fast trend, the line will always touch or cut the daily price bars.

As you increase the number of periods, the line will tend to trail a fast moving trend more and more, the longer the period. Whether the moving average line will cut the price bars will depend on the strength of the trend and also how volatile the price action is.

For my method of investing, the best trends are those that rise strongly and consistently above a 260-day moving average.

Even with such a long-term moving average, weaker stocks will show the moving average weaving in and out of the price bars.

The best way to get a feel for this is to find a free internet based charting facility like

http://au.finance.yahoo.com/q/ta?s=BHP.AX

Take that chart and put various moving averages on it to see how the period affects the relationship between the price bars and the moving average line.

Then choose some different stocks and repeat the exercise. This should give you a better feel for how a moving average helps smooth the prices to show a trend.

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